My Best Pick 2016

Rajat Rajgarhia

Rajat Rajgarhia of Motilal Oswal on why he increasingly thinks Voltas is a cool stock to own

Soumik Kar

Selling air conditioners (ACs) is not exactly a cool job, but Pradeep Bakshi has worked remarkably hard to ensure that Voltas maintains its leadership position in the domestic aircon market after making it to the top in FY13 (May 2012, to be precise). In 2006, Voltas, which had by then sold off its refrigerator and washing businesses, was faced with the prospect of shutting down its AC division, which was then clocking sales of ₹500 crore and incurring an operating loss of ₹34 lakh. The Koreans, Japanese and Americans had entered the domestic market and edged Voltas out from the Top 5 ranking. The adverse turn of events saw the management give Bakshi the task of turning around the business or selling it off. Bakshi, of course, chose the more challenging option.

Once Bakshi took over, Voltas went in for an overhaul of its marketing, distribution and product innovation strategies. With a number of MNC players already present in a much commoditised market, Voltas positioned itself as an India-centric brand and ran a successful campaign called ‘India ka dil, India ka AC’. The other change was that the company, which was earlier selling only through sales/service dealers, made products available off-the-shelf at retailers. Realising that Indian consumers are extremely conscious of rising power bills, Voltas launched the energy-efficient AC in 2007 with the campaign ‘Save karo India’, three years before the government made energy rating mandatory. This was followed by the ‘Sensible cooling’ campaign in 2010 and the launch of the ‘All-weather AC’ in 2012.

The net effect: by mid 2012, Voltas was back on top and has since maintained its hold. From 14% market share in 2006, Voltas today is the market leader with a 21% share and clocks AC sales of over ₹2,500 crore and operating profit of over ₹350 crore. In the current year, it has launched the ‘All-weather SMART AC’ range, which saves up to 63% power and can be operated using a mobile phone.  The turnaround has also helped Voltas alter its revenue and profit profile. The electro-mechanical projects (EMP) business, which till five years ago dominated revenue, is no longer the driver, and instead the unitary cooling products business is driving top-line growth. In FY15, the latter accounted for 49% of revenue against 25% in FY10, while EMP contributed 43% against 65% over the same period. Ditto with the bottom line: while the profit before interest and tax (PBIT) for EMP in FY10 was ₹309 crore, today, it is down to ₹23 crore. In contrast, the unitary cooling business’ PBIT has nearly trebled from ₹120 crore to ₹350 crore.

Hot statistics

And there’s more to come. The Indian AC industry is at an inflection point, in our view — we expect it to clock a CAGR of 15% over FY17-20, led by a multitude of factors. These include low penetration levels of ACs in India, increasing urbanisation and rising income levels, which have made ACs a necessity instead of a luxury. Also, the proposed 7th Pay Commission hikes should lead to higher incomes and hence higher demand for ACs. Moreover, rising temperatures thanks to global warming have led to year-round usage of ACs in many parts of the country. As the per capita GDP of the country doubles over the next seven years, several consumption-led items will move from being luxuries to necessities, and ACs would top that list.

Voltas, a market leader in the domestic industry, is set to benefit from this. We believe that the stock is attractive considering this positive outlook. At 5%, the penetration levels of ACs in India is the lowest in southeast Asia (72% in Singapore, 53% in China and 50% in Indonesia). With rising income levels, we expect AC penetration levels to increase significantly in future. AC penetration in India is even lower than that for fridges (33%) and TVs (77%). This offers a huge opportunity for the industry, as there is a lot of pent-up demand. 

Pay commission trigger

The 7th Pay Commission has submitted its recommendations on the proposed pay hike for central government employees effective 2016 onwards. Assuming this is accepted in its current form, there would be an additional ₹1 trillion paid out to central government employees in FY17. More importantly, states and PSUs also use the Pay Commission report as a base for salary revisions and, therefore, the overall impact would be even larger for the economy. In our view, there would be a surge in consumption-related expenditure over the next two years on account of the pay hikes for central, state and PSU employees. 

To put this in perspective, a similar trend had also been observed on account of the 6th Pay Commission. While the hikes are lower this time around (24%, versus 35% the last time around) and there will be no arrear payments (the 6th Pay Commission had 30 months of arrear payments), we would still expect a substantial jump on this account. We expect consumer durable sales to benefit — this would extend across white goods such as ACs, air coolers, fans and appliances. 

To put this in perspective, both FY10 and FY11 saw strong volume growth for the industry and for Voltas when the 6th Pay Commission notified salary increases from FY09 onwards, which led to an average 35% increase in salaries (paid in two installment: 40% in FY09 and 60% in 2010). Sales in FY09 were not as buoyant due to the slowdown in the economy post the global financial crisis and the lagged impact of the arrear payouts. In other words, the 7th Pay hike is a crucial trigger for industry sales.

But Voltas is not just relying on this swing factor to boost sales. In order to diversify its product range in the unitary cooling segment and as a natural extension of its existing brand, Voltas has recently diversified into air coolers. The move is to target consumers who want to upgrade from using a fan but find ACs expensive. Voltas started with the selective launch of coolers in Delhi, Punjab and Haryana and will gradually increase its presence across the country. It intends to be among the top three players in the country in the next three years but, for now, is focused primarily on the residential cooler market. The company hopes to sell 100,000 units in the first year of launch. It is focusing on the unorganised market and is setting up a new distribution channel for air coolers in tier 2 and tier 3 cities. The air cooler market is largely unorganised, with around 70% market share with unbranded players. Voltas aims to be among the top players in the segment in the next two to three years.

Primed for growth

Going ahead, we expect growth in the unitary cooling products (50% of sales) division to accelerate from FY17 led by the pent-up demand for ACs and implementation of pay hike recommendations. The projects segment (44% of sales) has also stabilised and we expect margins to improve from the current 2% to 5% in FY17. Return on equity will rise to a healthy 20% in FY17, even as Voltas remains a net cash company. We expect sales to clock a CAGR of 10% over FY15-17, while earnings net a CAGR of 19% over the same period. As economic activity picks up, earnings growth will remain strong driving improvement in return ratios and lay the ground for a multiple re-rating. In short, Voltas is a cool stock to own in 2016.

The brokerage has a buy call on the stock, but the writer in his personal capacity does not own the stock

This is Rajat Rajgarhia's best pick for 2016, you might be interested in what he recommended for 2014